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Saturday, February 23, 2008

Ooh, Bankers Lobbying Congress

It turns out that Bank of America has a nice little plan to solve the mortgage mess, which they have been submitting to your Congress Critters while y'all have been out there working to pay your mortgages. BofA, of course, has the little problem of the CW loans it just bought to deal with, and Congress Critters are relatively cheap in comparison to deeply underwater loans. Tanta's got the story.

A brief summary:
A few observations:
  1. It seems unlikely that the original deep discount will actually be the appropriate discount. First, there is no government agency that has the staff to determine what the actual secured value of these mortgages now are. Therefore it seems that the entities selling the bad mortgage loans to the federal government (that's you) will determine what the appropriate "deep discount" will be.
  2. Since the bad loans are concentrated in high LTV, stated/low-doc mortgages, there is no way to know what they can really pay. Thus the government guarantee is the real meat of this proposal. You will guarantee the banks and their shareholders to pay off their bad mortgages.
Logically, there are only two possibilities. The first is that the deep discount is figured appropriately, in which case this proposal does absolutely nothing to redress the situation. The current creditors will take the loss they were going to take. The second is that the deep discount is figured at (Cost of Congress Critters + 5%), and that you pay a much higher than market price for these mortgages. This would work out very well for the banks and creditors. It wouldn't work out very well for the borrowers, because most of them would still end up losing their houses. But you would end up refunding the losses to the creditors when they do, so the banks and other creditors wouldn't bother their little heads about trying to work out and cram down these mortgages.

If the American public is willing to let Congress do this, the American public deserves what it is going to get. Remember, it is an election year. Congress Critters are cheap for businesses, but only human beings vote.

My alternate proposal is that we let the current creditors and banks write down these mortgages, and that when the banks fail we pay off the depositors, and then inject money into the system as needed by giving reserve and necessary capital to the most viable banks. In exchange, the federal government (that's you) will take a partial ownership position (stock) in the banks. That ownership position should be put into a fund that is assigned to pay all its profits to the SS/Medicare trust funds. Believe me; whatever money we get out of it we will need later to pay these benefits.

My proposal has the following benefits:

I'm afraid you plan has a major flaw in it. I don't see any big fees to the Banks and Investment Banks.
But MoM,the banks are only trying to "Help the Children of middle class Americans!" out of a sense of civic duty!
I like your plan a lot better (it's less likely to involve a government default, and it appropriately punishes the greedy scum who made this mess) but I think you underestimate the level of pain the deflation will cause.
But John, the other plan doesn't stop the deflation either. No one can get people to pay bills they cannot pay. Whether the banks cram down or the government crams down, the reason for cramming down is to limit deflation. In practice, it will only be done when it is cheaper for creditor to write down the principal anyway.

We can inflate like Argentina or accept some temporary deflation. There's no alternative between the two.

The only thing the other plan does is shift losses from the banks and financial shareholders to the taxpayer.

CF is right. They won't get a piece of the action in my plan. I think that's a benefit.

Anon - Very funny.
CF - sorry about that! I realize that these govt guaranteed loans would be a juicy hedgie bite, but there's plenty of juice out there right now anyway.
John - just to clarify - the real way the banks and creditors would make money is that the federal government would pick up some of the principal loss plus guarantee future performance. So they would never have any incentive to work out a loan under BofA's brilliant plan.

Their plan is more deflationary than mine.
Once again : Privatize profits, socialize losses. The American way.

I haven't seen a discussion of this yet but ,IMO, the US has entered into a negative sum economy where the various classes will fight over an ever shrinking pie. Actually we have probably been in this condition for a decade but massive debt increases papered over the situation.

But not anymore and it is not going to be pretty. The ruling class has considerable assets to protect their privlege and will fight tooth and nail. We are at a tipping point and the destination is a much smaller middle class.

Hate to be negative but the world cannot afford the current American middle class and similar ones in China, India, and other emerging economies.

If we are at peak oil, then the global economy is approaching negative sum with associated commodity wars. Iraq may be seen as the first oil war.

Have a good weekend.

I like your plan, except I'm concerned that substantial government ownership postion in banks will lead to the politicization of all banking decisions...I really don't want Congress deciding where new branches and corporate HQs go, based on pork-barrel thinking.

How about the government gets warrants or preferred stock, something that doesn't have voting rights? Also require any banks bailed out under this provision to meet certain provisions in terms of insider stock purchases, to ensure skin in the game.
I thought BofA made enough money to buy the world by issuing blanket credit cards to criminal (illegal to some) Mexicans.

with your permission i would like to email your excellent post to the WSJ. your ideas need to become mainstream.
MoM, I wasn't disagreeing with your assessment of the BoA plan (at least now we know what they were promised in order to be enticed into buying Countrywide!). I'm just saying that I don't think the deflation will be short -- the last time here took more than a decade, the Japanese still haven't gotten back to health two decades after their bubble -- this is going to go on for a long while.
oh well. w/o your permission i sent this post to Greg Ip at WSJ. hope he says something about it.
idoc - I do sometimes sleep. You have my permission. I must say I woke up this morning as floored by this as when I went to bed.

It seems to me that we are seeing a vast and overweening arrogance in play here.
John - essentially Volcker did the same when he raised interest rates so high. The result was to drive investment into fundamental productivity, which produced long term results that were very good indeed. I am not denying the short term pain, but I do not even see that we can stop the deflation.
David - my concern is that the management of these institutions has been lacking, and that if the public takes a substantial ownership interest some of it may be diverted to inappropriate purposes.

How about members of the FHLB on the boards as a rotating panel? I understand your concerns, but what has led to the current crisis is the lethal practice of managing financials quarter by quarter, which dumped large chunks of bonus money into the pockets of individuals who were running these institutions right into the ground.
MOM..."what has led to the current crisis is the lethal practice of managing financials quarter by quarter"..the ownership requirements to be imposed on top management of bailed-out institutions could be in the form of options or restricted stock, either with a vesting schedule long enough to get attention focused beyond next quarter.
MoM, the difference is that Volcker was pricing people out of the market through interest rates, which is a temporary thing (when rates go back down, borrowing goes back up).

This time we're doing it by destroying capital, and that's a more lasting condition. It changes the zeitgeist; the government can't make investors make loans they don't want to make, and they can't make people borrow who don't want to borrow.

I also don't think it's wise for government to own equity positions long-term; once the government has a direct financial stake in picking winners and losers in the market, watch out!

Final thought: last time we had deflation here, it took destroying and rebuilding the infrastructure of Europe and Japan to produce enough demand to pull the economy out of depression. I sincerely hope we're not going to use that method to get out of this round.
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